INVESTING WITH CLARITY® BLOG

The Return of Volatility

April 2, 2018 4:59:45 PM

Volatility is back!

After the S&P 500 bounced off of the 200 day moving average last week, it looked very unlikely that we would retest that level. The bounce last week was the second leg of a double bottom that started during the February correction. However, although that bounce was a strong indicator that we would not re-test that level, today we saw a steep decline, bringing us below the 200 day moving average. There is an explanation for this move though, and we would sum up the move with three phrases. Tough talk on tariffs, De-Fanging of FANG, and Fear of the Fed. While these issues do seem to be driving the market lower, the thing to remember is that the market prices in the worse case scenario. Therefore, while we will describe the possible risks associated with these headlines, remember that these negatives are already priced in. If things don't go as badly as expected, we will likely see buying pressure push the market back up.

Tough Talk on Tariffs

The tariff issue is to be here to stay, although the fears seem overblown. China just announced a list of their tariffs in response to the tariffs that the Trump administration placed on Chinese goods. The tariffs that China enacted range from 15% to 25%, targeting many dried and fresh fruits, nuts, wine, steel, and a few other products. The total dollar value of these tariffs add up to nearly $3 billion. Putting that into perspective, in the year 2016, the US exported $115 billion worth of goods to China. Therefore these tariffs only represent 2.60% of the goods that the US exports to China. The greater fear here is that these tariffs will spark more tariffs which will spark even more tariffs, etc. But as it stands now, these tariffs are still very minimal, and therefore there impact on the economy should remain minimal. The uncertainty around the future of international trade is really what is contributing to this volatility. We view this volatility as an opportunity, and in the long run, fundamentals are what drive the stock market. Since the fundamentals remain strong, we do not view this Tough Talk on Tariffs as something to be too worried over.

Fear of The Fed

The Markets originally thought the the FED was going to raise rates three times in 2018. The recent commentary still suggests only three hikes, but the potential for a fourth hike has become greater based on the recent FED meeting

De-Fanging of FAANG

For quite some time, the stock market has been driven higher by the FANG stocks, that is, Facebook, Apple, Amazon, Netflix, and Google. Some investors may be surprised to learn how much of the S&P 500 index is made up of just these four names. These fives names actually make up close to 10.00% of the S&P 500.

This is a perfect week to re-vist the old headline vs. the bottom-line. As always, whenever there is volatility, the fear mongers take full advantage of the situation suggesting, like the Iron Maiden song, that investors should, "Run to the Hills". Below are some of the most ridiculous Headlines that have likely been seen by some of your clients. We will give you the Bottom-line so that you can cut through the noise and bring clarity to your clients. Here are some crazy Headlines from this week

U.S. Stock Market SELLOFF One of the BIGGEST IN HISTORY! Wild Panic Like 2009! (complete lie)

Dow Plunges 1,175, The Biggest Point Drop In History

Market crash stuns nation!

Now for the Bottom-line, heres what the world's largest asset manager, BlackRock, has to say.

This is the biggest decline in a short stretch since -11.2% in the six trading days 8/18/15- 8/25/15. Following that period, it took 48 trading days to recoup those loses (11/2/15 price only). A similar stretch occurred in 2011 from 7/22/11 close to 8/8/11 (11 trading days) where the S&P 500 was -16.8%. It took 126 days to recoup those loses (2/7/12 price only).

Very common for volatile days to cluster together especially when you get a large -4% move like Monday’s. Looking back at the last -4% day on 8/18/11 (-4.5%) there were 10 +/- 2%trading days in the 30 days after 8/18/11. Since 1950, there have been 43 single trading days with a 4% or greater loss and on average, the next 30 days had 12 +/- 2% trading days.

Remember, going into February, the S&P 500 was up a record 15 straight months (36.2% cum return) including all 12 months in 2017 (first yr in history all 12 months were positive).

To follow that up, here are some charts that help support these points.

Chart #1: One Year Price Return and P/E ratio of S&P 500

Chart #2 - Big January leading to strong Year End gains, despite intra-Year declines

As seen in the chart below, historically when we've had a strong January, we usually see above average year end returns, despite seeing an average intra-year drop of 10.07%. Take note of all of the years where we saw double digit intra-year declines, only to end the yearly with double digit gains. If history is to be any guide, this could still be a great year.

Chart #3 - How low will we go?

Of course nobody knows…the truisms of all truisms no doubt… However, we can look at history for suggestion as to what may be in store. Yes these days are rare but not as rare as one would think (two consecutive days when 90% of stocks traded to the downside within a four day period) Look at what happens out 3, 5, and 10 days.

Source: Deutsche Bank Research

Chart #4 - Corrections can happen within Bull Markets

Conclusion - Volatility creates Opportunity!

While this is a return to volatility, as supported in the charts above, it is not a time to panic. Volatility is normal and should always be expected when investing in stocks. We have been raising some cash using our Sell Disciplines and are assessing the opportunities as prices continue lower. We have been long time believers in the idea that volatility presents us with great opportunities, using Strategic Cost Averaging!

“Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.” – Peter Lynch

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